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As we approach the end of the calendar year, it’s a good time to start thinking about Tax Free Savings Accounts (TFSAs). Although many Canadians currently have a TFSA, a CIBC poll conducted by Harris/Decima last summer suggests that they simply aren’t using them. Forty-seven per cent of respondents indicated they had set up a TFSA. However, only half of those respondents said they have made a contribution this year.

In a nutshell, a TFSA is like a box. Every year account holders can contribute up to $5,000 worth of any investment product they choose depending on the institution they’re dealing with. (The maximum annual contribution is increasing to $5,500 on Jan. 1). These can be stocks, bonds, mutual funds, etc.

As opposed to an RRSP, it’s not permissible to deduct TFSA contributions on your tax return, but there’s no tax on any money you withdraw. This includes any profits that are made while your money is in the account.

“It’s a huge gift as far as I see it from the government. They’re telling you that whatever gains you make, whether you quadruple your money with a stock or play it safer with a term or fixed income product, they won’t tax you on the money,” says Jamal Khalil, an investment area manager with the Bank of Montreal.

There are other differences between TFSAs and RRSPs that you should be aware of. For example, RRSPs are only available to Canadians under the age of 71 who are earning an income, whereas TFSAs are open to anyone age 18 and over. Furthermore, unlike with RRSPs, amounts withdrawn in a year will be added to the TFSA holder’s accumulated contribution room in the next year, so that monies withdrawn can be re-contributed.

“Often people just don’t take the time to go see a financial planner/adviser even though at banks it’s free to speak with someone. As a result not enough time is devoted to thinking about one of the most important stages of your life, which is retirement. Nowadays, people fail to consider the higher-life expectancy and thus longer retirement periods. It’s important to make sure you’re benefiting from every single advantage the government is giving you,” Khalil says.

Trying to get a grip on TFSAs can be confusing. To help provide readers of the Gazette with a better understanding about this financial vehicle, Khalil offered the following five points:

Sometimes you are better off investing in a TFSA instead of a RRSP

There’s a belief among the general public that contributions should be made to RRSPs first and then to TFSAs. Many people have been taught to maximize their RRSP and put whatever is left over in a TFSA. It’s a misconception, especially for people who foresee having a higher income in the future. In their cases, it’s better to put that money into a TFSA. This allows their money to work for them tax-free. Once their income goes to a higher bracket, it then makes more sense to contribute to an RRSP and benefit from a tax return at a higher level.

Be efficient when investing in a TFSA

A lot of people don’t necessarily put the best financial products in a TFSA. Dividends, capital gains and any revenues from the investment that you make is tax sheltered. You don’t pay a single penny in tax when you take it out. Nevertheless, many people still put a Guaranteed Income Certificate or the equivalent in a TFSA and as a result they get a return on their money that is often lower than the inflation rate. If a TFSA contribution is maxed out at a yearly interest rate of 1.5 per cent, this translates to a tax saving of roughly $75. That’s not much. It’s like owning a Ferrari, but never shifting higher than first or second gear.

Set up TFSAs for your spouse and children

All Canadians over the age of 18 are eligible for a TFSA. Take advantage of the tax savings afforded by TFSAs by opening accounts for all adult members of your household. It’s permissible to transfer property or funds to your spouse who can then make a contribution to his or her account. Unlike a spousal RRSP, the amount that can be contributed is based on the spouse’s TFSA contribution room and can only be made by your spouse, the holder of the account. The same rules apply for an adult child.

Set pre-authorized contribution amounts

People have a hard time being disciplined with regards to saving money. By setting pre-authorized contributions on a weekly, bi-weekly or a monthly basis for whatever amount you’re comfortable with, you’ll end up maxing out your TFSA or putting a very decent amount in there. Pre-authorized contributions on a regular basis help to average out the purchase price of mutual funds, stocks or other investments. They also help you gather return on money that was first invested during the beginning of the year, as opposed to just putting in a lump sum at the end of the year. By going with the latter option, you miss out on eight to 12 months of returns.

The earlier you start, the better off you are

To get the most out of a TFSA, start saving as soon as you can. To illustrate this point, take the following example. An individual who makes the maximum monthly contribution of $458 over a 35-year period will stash away $192,500. At a modest annual rate of return of five per cent, the money in the TFSA will grow to $522,498. Thus, the TFSA will have generated $329,998 of tax-free income.

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